A Small Open Economy Model with Financial Accelerator for Bulgaria: The Role of Fiscal Policy

and the Currency Board

Ivan Lozev

December 2010

BULGARIANNATIONALBANK

DISCUSSION PAPERSDISCUSSION PAPERSDP/81/2010

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© Ivan Lozev, 2010

© Bulgarian National Bank, series, 2010

ISBN: 978–954–8579–39–1

Printed in the BNB Printing Centre.

Views expressed in materials are those of the authors and do not necessarily reflect BNB policy.

Elements of the 1999 banknote with a nominal value of 50 levs are used in cover design.

Send your comments and opinions to:Publications DivisionBulgarian National Bank1, Knyaz Alexander I Square1000 Sofia, BulgariaTel.: (+359 2) 9145 1351, 9145 1978Fax: (+359 2) 980 2425e–mail: Dimova.L@bnbank.org

Website: www.bnb.bg

DISCUSSION PAPERSEditorial Board:

Chairman: Ass. prof. Statty Stattev, Ph. D.

Members: Kalin Hristov Tsvetan Manchev, Ph. D. Ass. prof. Mariella Nenova, Ph. D. Ass. prof. Pavlina Anachkova, Ph. D. Andrey Vassilev, Ph. D. Daniela Minkova, Ph. D.

Secretary: Lyudmila Dimova

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1. Introduction .......................................................................................5

2. The Model ..........................................................................................6

2.1. Households .....................................................................................7

2.1.1. Consumption and Price Index .................................................7

2.1.2.Household optimization problem ............................................8

2.1.3. First Order Conditions Maximizing Discounted Household Utility ......................................................................9

2.2. External Sector ................................................................................9

2.3. Firms ...............................................................................................10

2.3.1. Capital Producers .....................................................................10

2.3.2. Entrepreneurs, Financing and Production of Wholesale Goods ................................................................11

2.3.3. Retail Sector...............................................................................13

2.4. Fiscal and Monetary Authorities ...............................................15

2.5. Supply, Demand and Market Equilibrium ...............................17

3. Model Parametrization ................................................................. 17

4. Model Simulation .......................................................................... 18

4.1. Increase in International Interest Rate .....................................19

4.2. Negative Total Factor Productivity Shock ...............................20

5. Conclusion and Directions for Future Work ............................ 21

References ............................................................................................... 22

Appendix 1. Dynare Code ................................................................... 23

Appendix 2. Transitional Dynamics of Selected Variables ............. 26

Contents

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SUMMARY. A small open economy DSGE model with financial accelerator and monetary pol-icy following currency board arrangement is presented. The specification builds on the work of Gertler et al. (2001, 2003) and extends it by implementing government that follows optimal simple rule and monetary authority obeying the rule of currency board arrangement. The model is calibrated to represent certain stylized facts about Bulgarian economy. Two temporary shocks are considered: an increase in international interest rate and a decrease in total factor produc-tivity in the modeling economy. The roles of financial accelerator mechanism as well as fiscal policy rule are discussed.

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1. IntroductionStandard DSGE models typically do not model financial linkages explic-

itly and consequently such models are not suitable for analyzing effects of changes in credit conditions on the real side of the economy. This simplifi-cation is due to the well-known Modigliani – Miller theorem, which states that with well-functioning markets and rational investors the value of the firm should not be affected by the share of debt in its financial structure (see Modigliani (1980), p. xiii).

In practice, however, during many economic crises financial markets played an important role in the amplification of the original shocks or have even been the source of original shock on their own. The financial accel-erator mechanism is one of the approaches allowing positive relationship between the financial conditions and the real side of the economy and vice versa (Bernanke et al. (1998)). Another popular approach uses collateral constraints (Kiyotaki and Moore (1997)). Financial accelerator relaxes the as-sumption of symmetric information and includes costly state verification. The inclusion of a financial accelerator brings about the following results:

• the additional costs in case of bankruptcy induce a risk premium over the economy-wide interest rate;

• these costs (and the premium) are procyclical because the financial position and default rates of firms are also procyclical;

• the price of capital is also procyclical as investment itself is procyclical; • combining the two effects above results in amplification and propaga-

tion of shocks in the economy;The mechanism of financial accelerator is realized through two main

channels. First, in case of an unexpected shock to the return of firm’s project the loss is borne entirely by the entrepreneur, while the bank still continues to receive debt repayments. As a result, the shock on the financial position is more than proportionate to the original shock to the return of the projects. The effect is more pronounced when the firm is more leveraged. Second, the deteriorated financial position increases the probability of default which pushes up the external financing premium which in turn further damages the financial situation of the enterprizes.

The financial sector in Bulgaria is deepening fast and the access to credit has been improving in the recent years. This trend assigns more importance to financial conditions changes in the firms’ decision making and provides a motivation to include the financial sector in the model. Furthermore, the international financial and economic crisis that started in 2008, apart from the trade channel, affected the Bulgarian economy through lower lending ac-tivity by the banking sector (mostly foreign owned). The implications arising

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from a currency board type monetary policy and active fiscal policy are also quite relevant for the case of Bulgaria.

The paper develops a small open economy DSGE model with financial accelerator a la Gertler et al. (2001, 2003). The model is extended to include the currency board arrangement (CBA) feature for Bulgaria. With the fiscal policy being the major policy instrument at hand, the question on how the government should react to different shocks to the economy in order to stabilize key economic variables becomes even more important. An optimal simple rule for conducting fiscal policy is obtained. The presence of finan-cial accelerator and its significance for determining fiscal policy response is also discussed. The main mechanisms of reaction to different shocks are explained.

The second section describes the model structure while the third sec-tion explains the parametrization approach. The fourth section discusses the simulation results from shocks in the international interest rate and in pro-ductivity. The role of the financial accelerator and fiscal policy is discussed there. The fifth section concludes and outlines the directions for future work. Appendix 1 gives the equations that are included in the model code and Ap-pendix 2 plots the impulse responses of the different shocks to the economy.

2. The ModelThe model structure follows closely that of Gertler et al. (2001, 2003).

The financial accelerator is an amplifying mechanism because the financial position of the firm affects the credit conditions and consequently deter-mines investment decisions (demand for capital).

In contrast to Gertler et al. (2001, 2003) having no autonomous fiscal policy, in our model the government may accumulate fiscal reserves and use government spending conditional on meeting its budget constraint. The central bank is modeled in a way that captures the specificities of CBA in Bul-garia. In the current context it means that International Reserves should fully cover the currency in circulation and the fiscal reserve within the Central Bank, like in Iordanov and Vassilev (2008).

The model consists of five sectors: households, firms (entrepreneurs, capi-tal producers and retailers), fiscal and monetary authority and external sec-tor. Households supply labour, save and consume domestic and imported goods. The corporate sector includes entrepreneurs, capital producers and retailers. Entrepreneurs produce wholesale goods and borrow from financial intermediaries to finance capital accumulation necessary for production. The asymmetry of information creates bankruptcy costs borne by the financial intermediaries. That in turn induces variation in external financing premium

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and influences demand for capital. Capital producers supply capital incurring additional costs that are proportionate to the ratio of investment over capital. Retailers costlessly combine wholesale goods supplied by entrepreneurs. Re-tail market structure is monopolistic competition and prices are rigid. Mon-etary authority follows the principles of CBA. The government formulates the fiscal policy in order to minimize the deviation of output and domestic inflation from their steady-state values.

Each sector is described in more detail below. The steady-state values of the variables are written with a bar, e.g. B, PF

t, etc.

2.1. Households

2.1.1. Consumption and Price Index

Households consume only tradable goods and combine domestic goods (CH) with imported ones (CF). CH and CF are incomplete substitutes. The consumption index (C) for any combination (CH, CF) takes the form of a CES function:

Households choose a combination (CH, CF) in order to minimize their costs given the value of total consumption (C) and prices of domestic (PH) and foreign (PF) goods.

s.t.

Solving the above problem, an expression linking the relative prices of domestic and foreign goods with their quantities as well as a consumer price index are obtained.

Ct =

[γ

1ρ CH

ρ−1ρ

t + (1 − γ)1ρ CF

ρ−1ρ

t

] ρρ−1

minCF ,CH

{P F CF + PHCH

}(1)

C =

[γ

1ρ CH

ρ−1ρ

+ (1 − γ)1ρ CF

ρ−1ρ

] ρρ−1

(2)

CHt

CFt

=γ

1 − γ

(PH

t

P Ft

)−ρ

(3)

Pt =

[γPH1−ρ

t + (1 − γ)P F 1−ρ

t

] 11−ρ

(4)

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2.1.2. Household optimization problem

Household behavior is modeled in a standard fashion common in most DSGE models. Households earn labour income (W) and real dividends from retailer’s profits (Π). They also consume (C), pay lump-sum taxes in real terms (T), hold cash balances (M) and save within financial intermediaries in local (B) and in foreign (B*) currency. They receive interest (i,i*) on their local and foreign currency savings respectively.

The allocation mechanism between savings in domestic (B) and foreign (B*) currency deserves further clarification. In Gertler et al. (2001, 2003) savings in domestic currency are in fact corporate bond purchases. B is the result of investment decisions of entrepreneurs and their net worth. House-holds are indifferent between saving in domestic and foreign currency as the return of these alternative investments is the same (due to the uncovered interest parity condition (UIP)). Consequently, B* is a residual of saving deci-sions of households and bonds B issued by corporate entrepreneurs.

The saving setup described above differs substantially from the common practice in Bulgaria. However, slight modification of B and B* interpretation brings the model setup close to the Bulgarian case. Following Bernanke et al. (1998), households save exclusively in financial intermediaries (banks). Total savings are B + SB* and under fixed exchange rate we calibrate S

t = 1 for ∀t.

Now B is the part of savings channeled to corporate sector by banks, while B* is private saving (borrowing) that banks channel (borrow from) abroad.

Households maximize their discounted utility. The within-period utility depends on consumption (C), cash holdings in real terms (M_

P ) and leisure

(1 − L).

The within-period utility includes also lagged consumption in order to model habit formation and consumption inertia. This allows for smoother re-action of consumption in response to real interest rate changes. The interest rate on savings in foreign currency ((1 + i*

t-i)�

t) depends on the net position

of households (B*), i.e. �'(B*) < 0 and �(B) = 1, where B* is the steady-state value of savings in foreign currency and � is the country risk premium. Consequently, if B*

t < B* , the interest rate on savings in foreign currency will

exceed the risk-free international interest rate (1 + i*t-1

). The functional form follows Iordanov and Vassilev (2008) (�R = 0.04%)

maxC,L,M,B,B∗

{Et

∞∑i=0

βi

[log(Ct+i − bCt+i−1) + ϕ log

(Mt+i

Pt+i

)+ κ log(1 − Lt+i)

]}(5)

s.t.

Ct =Wt

Pt

Lt+Πt−PHt

Pt

Tt−Mt − Mt−1

Pt

−Bt+1 − (1 + it−1)Bt

Pt

−St

B∗t+1 − (1 + i∗t−1)ΘtB

∗t

Pt

(6)

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Θt = Θ(Bt∗) = ψR

(exp

(−B∗

t − B∗

PHt Yt

)− 1

)+ 1 (7)

Including small risk premium linked to the external position of the econ-omy is a necessary condition to ensure stationary external position of the economy. In the absence of such a condition, the exogenous shocks will cause net external assets (liabilities) to exhibit random walk property (Sch-mitt-Grohe and Uribe (2003)). This risk premium vanishes in the steady state and the elasticity to deviations of external position from steady-state is small, so this friction does not affect the short-term dynamics of the system.

2.1.3. First Order Conditions Maximizing Discounted Household Utility

The equations maximizing (5) s.t. (6) are:• Labour supply

• Consumption and saving

• Cash balances

Equations (8)–(12) together with the budget constraint (6) describe the solution of household optimization problem.

2.2. External SectorThe external sector is exogenous. International nominal interest rate

(1 + i*t) is determined outside the model. For the purpose of stochastic sim-

ulations international nominal interest rate is modeled as AR(1) stationary process.

λtWt

Pt

= κ1

1 − Lt

(8)

λt = βEt

{λt+1(1 + it)

Pt

Pt+1

}(9)

Et

{λt+1

Pt

Pt+1

[(1 + it) − Θt(1 + i∗t )

St+1

St

]}= 0 (10)

λt =1

Ct − bCt−1

− βb

Ct+1 − bCt

(11)

λt

(Mt

Pt

)(1 − 1

1 + it

)= ϕ (12)

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where The price of foreign goods in foreign currency (P

tF*) translates to price in

domestic currency (PtF) obeying the law of one price.

Analogously, the law of one price transforms the price of domestically produced goods to price of exports in foreign currency.

We set PtF* = 1 and S

t = 1 for ∀t. In steady state the terms of trade are

calibrated at unity

External demand for domestically produced goods depends on the world output (Y

t*) and the price of exported goods (P

tH*) relative to international

price level (Pt*).

The downward sloping demand schedule can be derived by analogy from the equation of domestic demand the retailers are facing (see 2.3.3). The assumption of small open economy allows the international price level and level of output to be independent on domestic prices and output.

2.3. Firms

2.3.1. Capital Producers

Capital producers operate under perfect competition. Capital produc-tion involves adjustment costs apart from purchases of domestic and foreign goods. Inclusion of adjustment costs is motivated by two reasons. First, they add inertia to the dynamics of capital formation. Second, they create varia-tion in the price of capital induced by variation in investment. Similarly to the consumption index, the index of total investment combines goods produced domestically and imported from abroad.

By analogy to consumption (3) and consumer price index (4) a link be-tween relative prices and quantities of domestic and imported goods is ob-tained.

ρR = 0.95 и eR ∼ N(0, σ2R).

P Ft = StP

F ∗t

PHt = StP

H∗t

tP

F

PH = 1.

CH∗t =

(PH∗

t

P ∗t

)−ε

Y ∗t (14)

It =

[(γI)

1ρI IH

ρI−1ρI

t + (1 − γI)1

ρI IFρI−1

ρI

t

] ρIρI−1

(15)

log(1 + i∗t ) − log(1 + i∗) = ρR(log(1 + i∗t−1) − log(1 + i∗)) + eRt , (13)

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Capital production technology is described by the following expression

The nominal profit realized by capital producers is

where Q is the price of capital.Capital producers maximize their profit with respect to I, deciding one

period in advance. The first order necessary condition with respect to I in-duces positive relation between investment and price of capital.

2.3.2. Entrepreneurs, Financing and Production of Wholesale Goods

The entrepreneurs produce wholesale goods under perfect competition, combining the factors of production – labour (L) and capital (K) – by Cobb – Douglas production function.

where

Entrepreneurs employ labour to equate the marginal productivity and the average wage (W)

where P� is the wholesale price.

IHt

IFt

=γI

1 − γI

(PH

t

P Ft

)−ρI

(16)

PI,t =

[γIP

H1−ρI

t + (1 − γI)PF 1−ρI

t

] 11−ρI

(17)

Φ

(It

Kt

)Kt = Kt+1 − (1 − δ)Kt (18)

Φ′ (·) > 0, Φ′′ (·) < 0, Φ (0) = 0

QtΦ

(It

Kt

)Kt − PI,tIt − Ptr

It Kt, (19)

Et−1

⎧⎨⎩ Qt

PI,t

−⎡⎣ 1

Φ′(

It

Kt

)⎤⎦⎫⎬⎭ = 0 (20)

Yt = AtKαt L1−α

t , (21)

log(At) − log(A) = ρA(log(At−1) − log(A)) + eAt , (22)

ρA = 0.95 , eA ∼ N(0, σ2A).

(1 − α)Yt

Lt

=Wt

P ωt

, (23)

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The above equation is derived from maximizing the expression for entre-preneurial gross operating profit AtK

αt L1−α

t − Wt

P ωtLt with respect to L.

Entrepreneurs purchase capital using their own funds in real terms (N) and borrowing (B). The budget constraint for capital accumulation takes the form of

At the end of each period the entrepreneur purchases the capital neces-sary for production in the next period. The price of capital is the current price. Entrepreneurs are risk neutral, meaning that the decisions are based on the expected values ignoring the uncertainty around them. The entrepre-neurial income in real terms (GY) comes from three distinct sources:

• Production of wholesale goods • Current value of capital after depreciation �

• Rent paid by capital producers for using the existing capital to pro-duce new capital

The rent equals the marginal productivity of existing capital in the produc-tion of new capital: The RHS of this expres-sion is obtained by first differencing (19) with respect to K.

The expected return on capital {1 + r kt+1

} equals total revenues minus labour costs, divided by the capital in previous period prices.

After substituting (23) and (25) in (26) we obtain

The purchase of capital is partially financed by external funds. The risk premium between the expected return and the economy-wide free interest rate depends on how heavily the firm is leveraged.

Qt

Pt

Kt+1 = Nt+1 +Bt+1

Pt

. (24)

s (P ω

t

PtYt)

(Qt

Pt(1 − δ)Kt)

(rIt Kt).

rIt = Qt

Pt

(Φ(

It

Kt

)− Φ′

(It

Kt

)It

Kt

).

( )

GYt =P ω

t

Pt

Yt +Qt

Pt

(1 − δ)Kt + rIt Kt (25)

Et

{1 + rk

t+1

}= Et

{GYt+1 − Wt+1

Pt+1Lt+1

Qt

PtKt+1

}(26)

Et

{1 + rk

t+1

}= Et

⎧⎨⎩

P ωt+1

Pt+1α Yt+1

Kt+1+ (1 − δ) Qt+1

Pt+1+ rI

t+1

Qt

Pt

⎫⎬⎭ (27)

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After the entrepreneur has put the factors into production, an idiosyn-cratic shock (�) on the return is realized and wholesale goods are produced. In case the return has been sufficiently high the debt is repayed. Otherwise the entrepreneur declares bankruptcy. In order to repay the debt, the entre-preneur can sell the firm’s capital. The remaining part is the net worth of the firm:

To avoid the possibility of entrepreneurs accumulating more net worth (V and N) than the capital necessary for production and become net savers, a constant exogenous death rate (�) is introduced. This makes the planning horizon finite with expected value of . The number of entrepreneurs is also constant as in every period the number of newly created firms matches that of firms exiting the market. Those who cease to operate make a small transfer (D) to the new firms. The rest of the net worth of exiting firms is con-sumed (Ce). The small transfer is necessary to ensure that newcomers pos-sess at least a small amount of start-up capital, so that the interest rate they pay does not tend to infinity.

2.3.3. Retail Sector

Retailers are presented as a continuum �∈[0,1]. They purchase wholesale goods from entrepreneurs and resell them to households, capital producers and government. Retailers costlessly differentiate the goods and in doing so they gain certain market power. The main reason for including retail sector is to obtain inflation inertia through Calvo pricing. The aggregated volume (Y) and price of retail goods (PH) take the following form

Et

{1 + rk

t+1

}= (1 + χ(·)) Et

{(1 + it)

Pt

Pt+1

}(28)

χt(·) = χ

(QtKt+1

PtNt+1

)

χ′t(·) > 0, χ (0) = 0, χ (∞) = ∞

Vt =(1 + rk

t

) Qt−1

Pt−1

Kt −[(1 + χ(·))

{(1 + it−1)

Pt−1

Pt

}]Bt

Pt−1

(29)

( )

Nt+1 = φVt + (1 − φ)Dt (30)

Cet = (1 − φ) (Vt − Dt)

Pt

PHt

(31)

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Consumers attempt to minimize their costs given the prices for each dif-ferentiated good.

s.t.

Solving the problem above downward sloping demand schedule facing each retailer is obtained.

In each period a fraction of randomly selected retailers (1 − �) are given the opportunity to set up a new price (P*H(�)) and face demand (Y*(�)) for the current period and possibly for some periods ahead if they don’t happen to update their prices again. By symmetry, all firms that are able to change their price choose the same level (P*H) and face the same demand (Y*). Then the overall price level is

or

In order to obtain a Philips curve, the approach described in Uhlig (1995) is used. Around the steady state the above equation can be written as

Retailers that are able to change their prices set the price level optimally to maximize the discounted profits, weighted by the probability (�) for the price to remain the same for the period.

Yt =

⎡⎣ 1∫

0

Yt(ζ)ϑ−1

ϑ dζ

⎤⎦

ϑϑ−1

PHt =

⎡⎣ 1∫

0

PHt (ζ)1−ϑ dζ

⎤⎦

1ϑ−1

(32)

minYt(ζ)

1∫0

PHt (ζ)Yt(ζ) dζ

Yt =

⎡⎣ 1∫

0

Yt(ζ)ϑ−1

ϑ dζ

⎤⎦

ϑϑ−1

Yt(ζ) =

(PH

t (ζ)

PHt

)−ϑ

Yt (33)

PHt =

[θPH1−ϑ

t−1 + (1 − θ)P ∗H1−ϑ

t

] 11−ϑ

PH1−ϑ

t =[θPH1−ϑ

t−1 + (1 − θ)P ∗H1−ϑ

t

]

PHt =

(PH

t−1

)θ (P ∗H

t

)1−θ (34)

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where is the discount factor. The first order condition for maximizing the above expression with respect to P*H after substituting (33) into (35) is

Log-linearizing around the steady state, the optimal price takes the form of

Taking the ratio and substituting the previous equation and (34) into it, one obtains the Philips curve

The markup varies with the gap between the current demand and the steady-state levels. The mechanism is as follows. When retailers that are not able to change consumer prices face higher demand, they respond by increasing purchases of wholesale goods from entrepreneurs. That bids-up the producer prices and because retailers hold their prices fixed, the mark-up shrinks. The same logic applies when demand is lower than steady-state values.

2.4. Fiscal and Monetary AuthoritiesThe approach to modeling public policy is substantially different from the

approach taken in Gertler et al. (2001, 2003).The monetary authority follows the principles of CBA. As already men-

tioned at the beginning of Section 2, according to the CBA setup, Interna-tional Reserves should fully cover the currency in circulation and the fiscal reserve within the central bank.

where F*t represents official foreign reserves within the central bank and

stands for government fiscal reserves.

∞∑k=0

θkEt−1

[Λt,k

P ∗Ht − P ω

t+k

Pt+k

Y ∗t+k

], (35)

∞∑k=0

θkEt−1

{Λt,k

(P ∗H

t

PHt+k

)−ϑ

Y ∗t+k

[P ∗H

t

Pt+k

−(

ϑ

ϑ − 1

)P ω

t+k

Pt+k

]}= 0 (36)

PHt

PHt−1

=

(μ

P ωt

PHt

) (1−θ)(1−βθ)θ

(PH

t+1

PHt

)β

(37)

P ∗Ht = μ

∏∞i=0

(P ω

t+i

)(1−βθ)(βθ)i

, where μ = 11−1/ϑ

.

StF∗t = Mt + Υt, (38)

e Λt,k = βk λt+k

λt

i i

P Ht

P Ht−1

(P H

t+1

P Ht

)−β

li

P ωt

P Ht

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The fiscal sector is extended. This extension seems natural, because in the absence of an active monetary policy, the fiscal policy becomes the main economic policy instrument. For reference, in the Gertler et al. (2001, 2003) model the government is not able to accumulate either reserves or debt. Expenditures are exogenous and revenues are adjusted to comply with the monetary policy rule. In the current model the government accumulates fis-cal reserves () and receives interest payments from the monetary authority depending on the international interest rate. Tax revenues are proportionate to output (T – fixed ratio of taxes to GDP).

Government expenditure (GH) follows a simple rule and is used for pur-chasing domestic goods only. Two types of simple rules are investigated in the model simulations below. First, the government aims at maintaining its reserves within the central bank constant by targeting balanced budget. This policy rule is rather passive and resembles the one in Gertler et al. (2001, 2003). In the second case, the government attempts to stabilize the econo-my by minimizing the gap between the actual and steady-state values of out-put and domestic inflation (d). Specifically, the (weighted) sum of the vari-ances of output and domestic inflation is minimized. Currently equal weights are assigned to the volatility of output and inflation. The simple rule specifies that the deviation of government expenditures from steady-state responds linearly to the deviations from steady-state of lagged output, lagged domes-tic inflation and lagged price of capital. To ensure stability of fiscal reserve, government spending reacts to the lagged values of fiscal reserve to output ratio (small letters indicate deviations from steady-state). The optimization problem is as follows:

s.t.

Coefficients �Y, �

P, �

Q and �

are chosen optimally to minimize the sum of

the variances of output and domestic inflation.The budget constraint of the government states that the central bank’s

profits are transferred directly to the government.

PHt Tt = TPH

t Yt (39)

minρY ,ρP ,ρQ,ρΥ

[σY + σd

π

]

gHt = ρY yt−1 + ρP πd

t−1 + ρQqt−1 + ρΥ(υt−1 − yt−1 − pHt−1) (40)

Υt =(1 + i∗t−1

)Υt−1 + i∗t−1Mt−1 + PH

t Tt − PHt GH

t . (41)

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2.5. Supply, Demand and Market EquilibriumReal output is given by the following equation

In the program code the last equation substitutes the household budget constraint. The equilibrium is obtained when Y from (42) equals Y from (21) by changing the overall price index (P

tH).

3. Model ParametrizationIn the parametrization exercise we try to uncover the parameters that

matter for the steady state by matching the values of financial and real ob-servables for the last few years. For the other parameters we either assume the same values as in Gertler et al. (2001, 2003), or shift the parameter val-ues to better reflect the specifics of Bulgarian economy.

Leverage ratio is calibrated at 1.75 according to the YB (2007). In order to ensure that steady state exists the discount factor of households (�) must equal (1 + i)−1. Calibrating � = 0.987, implies that the economy-wide interest rate is 5.4% (because in the steady state the price level is constant, real and nominal interest rates coincide). The reported deposit rate for households is 4.9% for 2008 according to BNB statistics. The steady state value is chosen relatively high in order to reflect country risk and more cautious international financial markets.

The return on capital is 10% (according to firms’ balance sheet data for 2007 (YB (2007)). The calibrated value is comparatively high which helps to obtain lower ratio of capital to quarterly output (around 4:1). The bankruptcy costs are calibrated at higher levels following Carlstrom and Fuerst (1996) ( = 0.2 in the current model, opposed to = 0.12 in Gertler et al. (2001, 2003)). As a residual, we obtain the interest rate on loans to firms at 6.7%. Under the current parametrization the NPL is set at 4.4% while 2008 values are 2.4%. The reported values differ from the calibrated ones. One reason would be that in the recent years the economic conditions were generally benign and the reported NPL level might be below the long-term values. Fur-thermore, the model setup allows for one-period loan contracts only while in the data long-term contacts are most common and a loan is classified as non-performing if the payment is delayed for 90 days. Higher spreads combined with low NPL levels and high return in the banking sector indicate that profits in the sector are above those implied by the perfect competition assumption. The current parametrization also suggests higher uncertainty in the individual return on capital log(�) ~ N(−(1/2)�2, �2), � = 0.35.

Yt = CHt + Ce

t + CH∗t + IH

t + GHt (42)

QK N

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The capital income share is calibrated at 30% – considerably lower than the reported figures but close to the commonly used values in other DSGE models. It is reasonable to assume that currently labour share in Bulgaria is lower than the marginal productivity of labour. This suggests using the com-monly used value rather than the reported figure.

Depreciation rate is chosen at 3.5% and is higher than the reported fig-ures (2.2%). This helps to reach higher ratio of investment to GDP of 14% (during the period 1998–2005 the value is 18%). Higher depreciation rate also reflects necessary upgrades in the obsolete productive capacity.

The share of imported investment goods is set at 40% following the data from Input Output Tables (2005).

The price of capital elasticity with respect to the level of investment is calibrated at lower levels than that in Gertler et al. (2001, 2003). The reason is that in countries with underdeveloped capital markets the value of the firm does not vary that much with the investment levels. The calibrated value bet-ter reflects the volatility and autocorrelation of investment and the correla-tion between investment and output found in the data for the previous years.

The retail margin over the wholesale price is set at 25%.The share of imported consumption goods to GDP is set at . For

2007 and 2008 the ratio is around 13%.Government consumption is set at 30% of GDP as a compromise be-

tween the SNA data of around 20% (accrual basis) and fiscal reporting data of around 40% (cash basis). The level of international reserves to GDP is 64% according to international investment position data.

The ratio of foreign debt to GDP is

4. Model SimulationTwo shocks to the model economy are considered – an increase in the

international interest rate and a fall in total factor productivity. The shocks follow AR(1) stationary process. The innovations are distributed normally N(0,�2), � = 0.01. The discussion of the simulation results concentrates on three issues:

• comment on the transitional dynamics of some variables and the link-ages accounting for them;

• highlighting the role of financial accelerator in the model;• comparison between the dynamics in response to shocks under differ-

ent simple fiscal policy rules.Following Gertler et al. (2001, 2003) and Bernanke et al. (1998), we iso-

late the role of financial accelerator by fixing the risk premium on its steady-

CF

Y= 0.2

−B∗

Y= 1.

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state levels and the simulations are not affected by the financial position of the entrepreneurs. The distance between the two trajectories – with and without financial accelerator – gives a measure of financial accelerator effect for the Bulgarian economy.

4.1. Increase in International Interest RateThe AR(1) coefficient is 0.95. Higher interest rates eventually lead to low-

er GDP and the main contributing factor is lower investment. At the begin-ning inflation drops dramatically to equate supply and demand. After that, inflation gradually picks up and temporarily stays above the steady-state level. The mechanism leading to these dynamics is explained below (see Appen-dix 2, Figure 1).

In the first period international interest rate increases and leads to higher domestic nominal interest rate (due to the UIP). Price rigidity helps real in-terest rate to increase as well. Higher real interest rate stimulates household saving B + B* and lowers current in favor of future consumption (habit for-mation partially dampens the response). Imported goods drop more than domestic ones because their relative prices increase. Exports increase driven by relative price changes as well. Lower prices and higher interest rates cause a drop in return on capital and lower net worth of entrepreneurs. To prevent further increase in risk premium because of higher leverage, firms curb ex-ternal financing and investment. This in turn brings down the price of capi-tal which further diminishes firms’ net worth and investment. This negative self-propelling mechanism gradually dies out as some firms exit the market, replaced by new entrants.

Labour income follows the downward path of nominal output but re-covers more quickly due to the lower average wages. Lower labour income constrains consumption below steady-state throughout the simulated period.

Under fixed exchange rate inflation necessarily picks up above steady-state levels after initial sharp drop. This pattern is necessary to bring relative prices and exports/imports to their steady-state levels.

Under the simplest baseline fiscal policy rule, similar to Gertler et al. (2001, 2003), the government levies taxes proportional to output and aims at constant fiscal reserves by changing government consumption. This pattern implies targeting balanced budget in every period. Apart from tax revenues, interest rate income is generated by holding fiscal reserve within the central bank. In real terms this income increases because it is negotiated in nomi-nal terms and prices fall below steady-state levels while international interest rates appreciate throughout the period.

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Money demand shrinks as return on deposits increases and prices and demand decrease. B and B* have opposite dynamics. As savings increase and demand for external financing by entrepreneurs decreases, banks chan-nel the excess savings abroad.

The response is more pronounced and prolonged because of the finan-cial accelerator mechanism. However, compared to the role of financial ac-celerator in Gertler et al. (2001, 2003), the difference is not so pronounced (see Appendix 2, Figure 1). The reason is the lower elasticity of price of capi-tal to investment and the lower leverage ratio.

As an alternative to the simplest fiscal policy rule aiming at constant fiscal reserves, a simple optimal fiscal policy rule is found. It specifies that govern-ment consumption reacts to GDP, domestic inflation and lagged price of capital in order to minimize the deviation of output and inflation form their steady state values.

The coefficients of reaction in (40) are �Y = −0.44, �P = −0.43 and �Q = −1.32 respectively. In the second period government consumption ris-es almost entirely compensating for the drop in investment (see Appendix 2, Figure 2). After that government consumption drops fast to its steady-state levels and even below in response to inflationary pressures and the mitigated drop in real output. To ensure that fiscal reserve returns to steady-state, government spending reacts to fiscal reserve changes. The coefficient is �

= 0.29 and the fiscal reserve returns to its steady state in approximately

20 periods (4 years).

4.2. Negative Total Factor Productivity ShockAgain, the AR(1) coefficient is 0.95. The mechanism that drives the dy-

namics of the model is described below (see Appendix 2, Figure 3).Higher domestic prices worsen the competitive position of exports, sup-

pressing exports below steady-state throughout the entire simulation period. Demand for production factors increases to compensate for lower produc-tivity. However, higher prices reduce real wages below steady-state. House-hold consumption does not respond to the temporary increase in wages as consumption depends on the discounted value of all future real income. The transitional dynamics of household consumption has a U-shape as inflation initially brings real interest rate down, postponing savings for later periods. After inflation abates, consumption starts to increase on a chain basis, driven by the changes in real interest rate.

Investment dynamics is determined by the demand for capital and its re-turn. In the first period the return on capital increases as the price of capital increases in response to intensified demand for production factors in period

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two. The financial position of entrepreneurs also improves because of the higher price of capital and lower real interest rate (higher inflation). The bet-ter financial position lowers the risk premium and further stimulates invest-ment.

Allowing for optimal fiscal simple rule affects the performance of the economy only marginally (see Appendix 2, Figure 4). The relative ineffective-ness of fiscal policy in offsetting the negative productivity shock is a well-documented fact (see Batini et al. (2009)). It stems from the two conflicting tasks – drop in real output and higher relative domestic prices.

5. Conclusion and Directions for Future WorkThe results presented above suggest that the current model structure and

dynamics is rich enough to analyze the developments in the real economy and the financial sector. The chosen parametrization relevant for Bulgaria assigns moderate role to financial accelerator mechanism. The government is able to counteract a positive shock to international interest rate. The inclu-sion of price of capital in the optimal rule improves the results. On the other hand, fiscal policy hardly offsets a negative productivity shock.

During parametrization several problems were encountered – the capital to GDP ratio is too high, while investment is much lower than the reported figures. Conversely, the default rates are too high compared to the data. Cali-brating positive external debt in the steady state suggests positive external balance which does not conform with the empirical evidence for Bulgaria in the recent years. This prompts to the fact that current values of trade deficits are away from the steady-state values. The directions for future work are de-rived from these problems:

• better parametrization to meet the data;• adding additional shocks (to external financing premia, for example);• structural changes in the model – adding stable growth path proper-

ties, adding labour market rigidities to disentangle the marginal labour productivity from average wage, including FDI flows to finance part of the current account;

• formulating alternative financial sector market structure to account for the higher concentration and higher profit margins.

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ReferencesInput Output Tables. National Statistical Institute, 2005. Statistical Yearbook. National Statistical Institute, 2007.Batini, Nicoletta, Paul Levine and Joseph Pearlman. Monetary and fiscal rules in

an emerging small open economy. IMF Working Paper Series, (WP/09/22), January 2009.

Bernanke, Ben, Mark Gertler and Simon Gilchrist. The financial accelerator in quantitative business cycles. NBER Working Paper Series (6455), March 1998.

Charles T. Carlstrom and Timothy S. Fuerst. Agency costs, net worth, and busi-ness fluctuations: a computable general equilibrium analysis. Technical report, 1996.

Gertler, Mark, Simon Gilchrist and Fabio Natalucci. External constraints on mon-etary policy and the financial accelerator. FRBSF Economic Letter, April – June 2001.

Gertler, Mark, Simon Gilchrist and Fabio Natalucci. External constraints on mon-etary policy and the financial accelerator. NBER Working Paper Series (10128), 2003.

Iordanov, Iordan and Andrey Vassilev. A small open economy model with a cur-rency board feature: the case of Bulgaria. BNB Discussion Papers (63), 2008.

Kiyotaki, Nobuhiro and John Moore. Credit cycles. Journal of Political Economy (105), 1997.

Modigliani, Franco. The Collected Papers of Franco Modigliani, volume 3. 1980.Schmitt-Grohe, Stephanie and Martin Uribe. Closing small open economy mod-

els. Journal of International Economics, 61(1):163–185, October 2003.Uhlig, Harald. A toolkit for analyzing nonlinear dynamic stochastic models easily.

Tilburg University, Center for Economic Research, Discussion Paper (97), 1995.

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The equations included in the Dynare code are shown below.

• Demand

Yt = CHt + Ce

t + CH∗t + IH

t + GHt [42]

λt =1

Ct − bCt−1

− βb

Ct+1 − bCt

[11]

λt = βEt

{λt+1(1 + it)

Pt

Pt+1

}[9]

C =

[γ

1ρ CH

ρ−1ρ

+ (1 − γ)1ρ CF

ρ−1ρ

] ρρ−1

[2]

CHt

CFt

=γ

1 − γ

(PH

t

P Ft

)−ρ

[3]

Pt =

[γPH1−ρ

t + (1 − γ)P F 1−ρ

t

] 11−ρ

[4]

CH∗t =

(PH∗

t

P ∗t

)−ε

Y ∗t [14]

It =

[(γI)

1ρI IH

ρI−1ρI

t + (1 − γI)1

ρI IFρI−1

ρI

t

] ρIρI−1

[15]

IHt

IFt

=γI

1 − γI

(PH

t

P Ft

)−ρI

[16]

PI,t =

[γIP

H1−ρI

t + (1 − γI)PF 1−ρI

t

] 11−ρI

[17]

Cet = (1 − φ) (Vt − Dt)

Pt

PHt

[31]

Appendix 1

Dynare Code

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gHt = ρY yt−1 + ρP πd

t−1 + ρQqt−1 + ρΥ(υt−1 − yt−1 − pHt−1) [40]

λt

(Mt

Pt

)(1 − 1

1 + it

)= ϕ [12]

(1 − α)Yt

Lt

=Wt

P ωt

[23]

Et

{1 + rk

t+1

}= Et

⎧⎨⎩

P ωt+1

Pt+1α Yt+1

Kt+1+ (1 − δ) Qt+1

Pt+1+ rI

t+1

Qt

Pt

⎫⎬⎭ [27]

• Supply

Yt = AtKαt L1−α

t [21]

λtWt

Pt

= κ1

1 − Lt

[8]

Et

{1 + rk

t+1

}= (1 + χ(·)) Et

{(1 + it)

Pt

Pt+1

}[28]

• Pricing and interest rates

Et−1

{Qt

PI,t

−[Φ′

(It

Kt

)−1]}

= 0 [20]

PHt

PHt−1

=

(μ

P ωt

PHt

) (1−θ)(1−βθ)θ

(PH

t+1

PHt

)β

[37]

Et

{λt+1

Pt

Pt+1

[(1 + it) − Θt(1 + i∗t )

St+1

St

]}= 0 [10]

Θ(B∗) = ψR

(exp

(−B∗

PHY

)− 1

)+ 1 [7]

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• Budget constraints and other identities

Φ

(It

Kt

)Kt = Kt+1 − (1 − δ)Kt [18]

Qt

Pt

Kt+1 = Nt+1 +Bt+1

Pt

[24]

Vt =(1 + rk

t

) Qt−1

Pt−1

Kt −[(1 + χ(·))

{(1 + it−1)

Pt−1

Pt

}]Bt

Pt−1

[29]

Nt+1 = φVt + (1 − φ)Dt [30]

CH∗t PH

t − CFt P F

t − P Ft IF

t = StF∗t − (

1 + i∗t−1

)StF

∗t−1 + St

(B∗

t+1 − (1 + i∗t−1)ΘtB∗t

)(43)

Υt =(1 + i∗t−1

)Υt−1 + i∗t−1Mt−1 + PH

t Tt − PHt GH

t [41]

PHt Tt = TPH

t Yt [39]

StF∗t = Mt + Υt [38]

• External finance premium

kt+1 =QtKt+1

PtNt+1

(44)

k = χ−1(·) (45)

• Exogenous shocks

log(1 + i∗t ) − log(1 + i∗) = ρR(log(1 + i∗t−1) − log(1 + i∗)) + eRt [13]

log(At) − log(A) = ρA(log(At−1) − log(A)) + eAt [22]

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5 10 15 20−1.5

−1

−0.5

0

Ye

5 10 15 20

−1

−0.5

0Ce

5 10 15 20

−0.4

−0.2

0Che

5 10 15 20

−2

−1

0Cfe

5 10 15 20

−10

−5

0Ie

5 10 15 200

1

2Ch*e

5 10 15 20

−1.5−1

−0.50

Le

5 10 15 20−3

−2

−1

0Wre

5 10 15 20−0.6−0.4−0.20

infle

5 10 15 20

−2

−1

0

Qre

5 10 15 20−2

−1

0

Rke

5 10 15 200

0.20.40.60.8

Rre

5 10 15 20−4

−2

0Ne

5 10 15 20

−1

−0.5

0Be

5 10 15 200

5

10

B*e

5 10 15 20

−1

−0.5

0

Ge

Figure 1

MODEL WITH (-) AND WITHOUT (- -) FINANCIAL ACCELERATOR – SHOCK TO INTERNATIONAL INTEREST RATE

Appendix 2

Transitional Dynamics of Selected VariablesThe figures below present the impulse responses of key economic vari-

ables following interest rate shock and productivity shock respectively. The magnitudes of the shocks equal one standard error, declared in the model code. All variables are presented as deviations from the steady-state. The titles Qr, Wr and Rr are the real counterparts of the price of capital, average wage and nominal country interest rate.

27

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5 10 15 20−1.5

−1

−0.5

0Ye

5 10 15 20

−1

−0.5

0Ce

5 10 15 20−0.6

−0.4

−0.2

0Che

5 10 15 20

−2

−1

0Cfe

5 10 15 20

−10

−5

0Ie

5 10 15 200

1

2Ch*e

5 10 15 20

−1.5−1

−0.50

Le

5 10 15 20−3

−2

−1

0Wre

5 10 15 20−0.6−0.4−0.20

infle

5 10 15 20

−2

−1

0

Qre

5 10 15 20−2

−1

0

Rke

5 10 15 200

0.20.40.60.8

Rre

5 10 15 20−4

−2

0Ne

5 10 15 20

−1.5

−1

−0.5

0Be

5 10 15 200

5

10

B*e

5 10 15 20−10123

Ge

Figure 2

MODEL WITH (- -) AND WITHOUT (-) OPTIMAL SIMPLE FISCAL POLICY RULE – SHOCK TO INTERNATIONAL INTEREST RATE

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5 10 15 20

−0.4

−0.2

0Ya

5 10 15 20

−0.2

−0.1

0Ca

5 10 15 20

−0.4

−0.2

0Cha

5 10 15 20−0.02

00.020.040.060.08

Cfa

5 10 15 20−1

−0.5

0

0.5

Ia

5 10 15 20

−0.4

−0.2

0Ch*a

5 10 15 200

0.2

0.4

0.6

La

5 10 15 20−0.3−0.2−0.10

0.1

Wra

5 10 15 200

0.050.10.15

infla

5 10 15 200

0.1

0.2

Qra

5 10 15 20

0

0.1

0.2Rka

5 10 15 20

−0.15

−0.1

−0.05

0

Rra

5 10 15 200

0.2

0.4

Na

5 10 15 20−0.6

−0.4

−0.2

0Ba

5 10 15 20−0.6

−0.4

−0.2

0B*a

5 10 15 20

−0.4

−0.2

0Ga

Figure 3

MODEL WITH (-) AND WITHOUT (- -) FINANCIAL ACCELERATOR – SHOCK TO TFP

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5 10 15 20

−0.4

−0.2

0Ya

5 10 15 20

−0.2

−0.1

0Ca

5 10 15 20

−0.4

−0.2

0Cha

5 10 15 20−0.02

00.020.040.060.08

Cfa

5 10 15 20−0.5

0

0.5

Ia

5 10 15 20

−0.4

−0.2

0Ch*a

5 10 15 200

0.2

0.4

0.6

La

5 10 15 20

−0.2−0.10

0.1

Wra

5 10 15 200

0.050.10.15

infla

5 10 15 200

0.1

0.2

Qra

5 10 15 20

0

0.1

0.2Rka

5 10 15 20

−0.15

−0.1

−0.05

0

Rra

5 10 15 200

0.2

0.4

Na

5 10 15 20

−0.15

−0.1

−0.05

0Ba

5 10 15 20−0.6

−0.4

−0.2

0B*a

5 10 15 20

−0.6

−0.4

−0.2

0Ga

Figure 4

MODEL WITH (- -) AND WITHOUT (-) OPTIMAL SIMPLE FISCAL POLICY RULE – SHOCK TO TFP

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DP/1/1998 The First Year of the Currency Board in BulgariaVictor Yotzov, Nikolay Nenovsky, Kalin Hristov, Iva Petrova, Boris Petrov

DP/2/1998 Financial Repression and Credit Rationing under Currency Board Arrangement for BulgariaNikolay Nenovsky, Kalin Hristov

DP/3/1999 Investment Incentives in Bulgaria: Assessment of the Net Tax Effect on the State Budget Dobrislav Dobrev, Boyko Tzenov, Peter Dobrev, John Ayerst

DP/4/1999 Two Approaches to Fixed Exchange Rate CrisesNikolay Nenovsky, Kalin Hristov, Boris Petrov

DP/5/1999 Monetary Sector Modeling in Bulgaria, 1913–1945Nikolay Nenovsky, Boris Petrov

DP/6/1999 The Role of a Currency Board in Financial Crises: The Case of BulgariaRoumen Avramov

DP/7/1999 The Bulgarian Financial Crisis of 1996–1997Zdravko Balyozov

DP/8/1999 The Economic Philosophy of Friedrich Hayek (The Centenary of His Birth)Nikolay Nenovsky

DP/9/1999 The Currency Board in Bulgaria: Design, Peculiarities and Management of Foreign Exchange CoverDobrislav Dobrev

DP/10/1999 Monetary Regimes and the Real Economy (Empirical Tests before and after the Introduction of the Currency Board in Bulgaria)Nikolay Nenovsky, Kalin Hristov

DP/11/1999 The Currency Board in Bulgaria: The First Two YearsJeffrey B. Miller

DP/12/2000 Fundamentals in Bulgarian Brady Bonds: Price DynamicsNina Budina, Tzvetan Manchev

DP/13/2000 Currency Circulation after Currency Board Introduction in Bulgaria (Transactions Demand, Hoarding, Shadow Economy)Nikolay Nenovsky, Kalin Hristov

DP/14/2000 Macroeconomic Models of the International Monetary Fund and the World Bank (Analysis of Theoretical Approaches and Evaluation of Their Effective Implementation in Bulgaria)Victor Yotzov

DP/15/2000 Bank Reserve Dynamics under Currency Board Arrangement for BulgariaBoris Petrov

DP/16/2000 A Possible Approach to Simulate Macroeconomic Development of BulgariaVictor Yotzov

DISCUSSION PAPERS

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DP/17/2001 Banking Supervision on Consolidated Basis (in Bulgarian only)Margarita Prandzheva

DP/18/2001 Real Wage Rigidity and the Monetary Regime ChoiceNikolay Nenovsky, Darina Koleva

DP/19/2001 The Financial System in the Bulgarian EconomyJeffrey Miller, Stefan Petranov

DP/20/2002 Forecasting Inflation via Electronic Markets Results from a Prototype ExperimentMichael Berlemann

DP/21/2002 Corporate Image of Commercial Banks (1996–1997) (in Bulgarian only)Miroslav Nedelchev

DP/22/2002 Fundamental Equilibrium Exchange Rates and Currency Boards: Evidence from Argentina and Estonia in the 90’sKalin Hristov

DP/23/2002 Credit Activity of Commercial Banks and Rationing in the Credit Market in Bulgaria (in Bulgarian only)Kalin Hristov, Mihail Mihailov

DP/24/2002 Balassa – Samuelson Effect in Bulgaria (in Bulgarian only)Georgi Choukalev

DP/25/2002 Money and Monetary Obligations: Nature, Stipulation, FulfilmentStanislav Natzev, Nachko Staykov, Filko Rosov

DP/26/2002 Regarding the Unilateral Euroization of BulgariaIvan Kostov, Jana Kostova

DP/27/2002 Shadowing the Euro: Bulgaria’s Monetary Policy Five Years on Martin Zaimov, Kalin Hristov

DP/28/2002 Improving Monetary Theory in Post-communist Countries – Looking Back to CantillonNikolay Nenovsky

DP/29/2003 Dual Inflation under the Currency Board: The Challenges of Bulgarian EU Accession (in Bulgarian only)Nikolay Nenovsky, Kalina Dimitrova

DP/30/2003 Exchange Rate Arrangements, Economic Policy and Inflation: Empirical Evidence for Latin AmericaAndreas Freytag

DP/31/2003 Inflation and the Bulgarian Currency BoardStacie Beck, Jeffrey B. Miller, Mohsen Saad

DP/32/2003 Banks – Firms Nexus under the Currency Board: Empirical Evidence from BulgariaNikolay Nenovsky, Evgeni Peev, Todor Yalamov

DP/33/2003 Modelling Inflation in Bulgaria: Markup Model (in Bulgarian only)Kalin Hristov, Mihail Mihailov

DP/34/2003 Competitiveness of the Bulgarian EconomyKonstantin Pashev

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DP/35/2003 Exploring the Currency Board Mechanics: A Basic Formal ModelJean-Baptiste Desquilbet, Nikolay Nenovsky

DP/36/2003 A Composite Tendency Indicator for Bulgaria’s Industry (in Bulgarian only)Tsvetan Tsalinsky

DP/37/2003 The Demand for Euro Cash: A Theoretical Model and Monetary Policy ImplicationsFranz Seitz

DP/38/2004 Credibility Level of the Bulgarian Exchange Rate Regime, 1991–2003: First Attempt at Calibration (in Bulgarian only)Georgi Ganev

DP/39/2004 Credibility and Adjustment: Gold Standards Versus Currency BoardsJean-Baptiste Desquilbet, Nikolay Nenovsky

DP/40/2004 The Currency Board: “The Only Game in Town” (in Bulgarian only)Kalin Hristov

DP/41/2004 The Relationship between Real Convergence and the Real Exchange Rate: the Case of BulgariaMariella Nenova

DP/42/2004 Effective Taxation of Labor, Capital and Consumption in Bulgaria (in Bulgarian only)Plamen Kaloyanchev

DP/43/2004 The 1911 Balance of Payments of the Kingdom of Bulgaria(in Bulgarian only)Martin Ivanov

DP/44/2004 Beliefs about Exchange Rate Stability: Survey Evidence from the Currency Board in BulgariaNeven T. Valev, John A. Carlson

DP/45/2005 Opportunities of Designing and Using the Money Circulation Balance (in Bulgarian only)Metodi Hristov

DP/46/2005 The Microeconomic Impact of Financial Crises: The Case of Bulgaria Jonathon Adams-Kane, Jamus Jerome Lim

DP/47/2005 Interest Rate Spreads of Commercial Banks in Bulgaria (in Bulgarian only)Mihail Mihailov

DP/48/2005 Total Factor Productivity Measurement: Accounting of Economic Growth in Bulgaria (in Bulgarian only)Kaloyan Ganev

DP/49/2005 An Attempt at Measurement of Core Inflation in Bulgaria (in Bulgarian only)Kalina Dimitrova

DP/50/2005 Economic and Monetary Union on the HorizonDr Tsvetan Manchev, Mincho Karavastev

DP/51/2005 The Brady Story of Bulgaria (in Bulgarian only)Garabed Minassian

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DP/52/2005 General Equilibrium View on the Trade Balance Dynamics in BulgariaHristo Valev

DP/53/2006 The Balkan Railways, International Capital and Banking from the End of the 19th Century until the Outbreak of the First World WarPeter Hertner

DP/54/2006 Bulgarian National Income between 1892 and 1924Martin Ivanov

DP/55/2006 The Role of Securities Investor Compensation Schemes for the Development of the Capital Market (in Bulgarian only)Mileti Mladenov, Irina Kazandzhieva

DP/56/2006 The Optimal Monetary Policy under Conditions of Indefiniteness (in Bulgarian only)Nedyalka Dimitrova

DP/57/2007 Two Approaches to Estimating the Potential Output of Bulgaria Tsvetan Tsalinski

DP/58/2007 Informal Sources of Credit and the “Soft” Information Market(Evidence from Sofia)Luc Tardieu

DP/59/2007 Do Common Currencies Reduce Exchange Rate Pass-through? Implications for Bulgaria’s Currency Board Slavi T. Slavov

DP/60/2007 The Bulgarian Economy on Its Way to the EMU: Economic Policy Results from a Small-scale Dynamic Stochastic General Equilibrium FrameworkJochen Blessing

DP/61/2007 Exchange Rate Control in Bulgaria in the Interwar Period: History and Theoretical ReflectionsNikolay Nenovsky, Kalina Dimitrova

DP/62/2007 Different Methodologies for National Income Accounting in Central and Eastern European Countries, 1950–1990Rossitsa Rangelova

DP/63/2008 A Small Open Economy Model with a Currency Board Feature: the Case of BulgariaIordan Iordanov, Andrey Vassilev

DP/64/2008 Potential Output Estimation Using Penalized Splines: The Case of BulgariaMohamad Khaled

DP/65/2008 Bank Lending and Asset Prices: Evidence from BulgariaMichael Frömmel, Kristina Karagyozova

DP/66/2008 Views from the Trenches: Interviewing Bank Officials in the Midst of a Credit BoomNeven Valev

DP/67/2008 Monetary Policy Transmission: Old Evidence and Some New Facts from BulgariaAlexandru Minea, Christophe Rault

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DP/68/2008 The Banking Sector and the Great Depression in Bulgaria, 1924–1938: Interlocking and Financial Sector ProfitabilityKiril Danailov Kossev

DP/69/2008 The Labour Market and Output in the UK – Does Okun’s Law Still Stand?Boris Petkov

DP/70/2008 Empirical Analisys of Inflation Persistence and Price Dynamics in BulgariaZornitsa Vladova, Svilen Pachedjiev

DP/71/2009 Testing the Weak-form Efficiency of the Bulgarian Stock MarketNikolay Angelov

DP/72/2009 Financial Development and Economic Growth in Bulgaria (1991–2006)An Econometric Analysis Based on the Logic of the Production FunctionStatty Stattev

DP/73/2009 Autonomy vs. Stability: The Relationship between Internal and External Money in Bulgaria (1879–1912)Luca Fantacci

DP/74/2009 The Size of the Shadow Economy in Bulgaria: A Measurement Using the Monetary Method Hildegart Ahumada, Facundo Alvarado, Alfredo Canavese, Nicolás Grosman

DP/75/2009 Efficiency of Commercial Banks in Bulgaria in the Wake of EU AccessionKiril Tochkov, Nikolay Nenovsky

DP/76/2009 Structural Current Account Imbalances: Fixed Versus Flexible Exchange Rates?Slavi T. Slavov

DP/77/2009 Econometric Forecasting of Bulgaria’s Export and Import Flows Grigor Stoevsky

DP/78/2009 Explanations for the Real Exchange Rate Development in the New EU Member States in TransitionGalina Boeva

DP/79/2009 The Great Depression in the Eyes of Bulgaria’s Inter-war Economists (How History of Economic Thought Could Matter for Today’s Policy Advice)Stefan Kolev

DP/80/2010 Modeling Interest Rates on Corporate Loans in Bulgaria (in Bulgarian only)Mihail Mihailov